Demystifying this three-digit number that controls a big chunk of your life

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Last week’s column on credit scores generated a lot of comments and questions. Olga, who says she has excellent credit, sent me an e-mail that sums up the frustration of so many. “I feel that no matter what a consumer does, no matter how careful you are with your credit, whatever you do, they tell you it could lower your credit score. A consumer cannot win!”

I understand the frustration. Your credit score now controls so many aspects of your life: whether you can rent an apartment or get a car loan, credit card or mortgage. I think everyone knows late payments will hurt their score. But other than that, most don’t have a clue as to how credit scores are computed.

Here are the answers to some of your questions.

Q: A department store chain is going out of business and I have one of their store-branded Visa cards. The bank that issued the card says once the store closes its doors for good they will close my account. Would it be better for my credit score if I close the card myself before the bank does?

A: It doesn’t matter who closes the account. That isn’t one of the factors considered when computing your credit score. But closing an account – whether it’s done by you or the lender – can have a short-term negative impact on your credit score. This is due to what’s called debt utilization – the ratio of your total debt to total credit limit – and it counts for about a third of your credit score.

“Closing a credit card reduces your available credit, but doesn’t reduce the amount you owe, making it look as if you’re using more of your available credit,” explains Greg McBride, senior financial analyst with bankrate.com.

Here’s how that works. Let’s say you have four credit cards and each has a $5,000 limit, making your available credit $20,000. You have no balance on one card and a combined balance of $6,000 on the other three. Your utilization rate is about 30 percent. That’s not bad. Credit experts say you should try to use 30 percent or less of your available credit.

What happens if you decide to close the card with the zero balance because you don’t use it anymore? Your available credit drops by $5,000 but your total debt doesn’t change. So your utilization rate jumps to 40 percent ($6,000 debt on $15,000 of available credit) and your credit score will drop.

Craig Watts, public relations manager at Fair Isaac, the company that created the FICO score, says if you close a card and you have virtually no balance on your other cards “the impact on your score will be negligible.” Watts says it won’t hurt you if you go from a 2 percent to a 10 percent utilization rate. But jump from 10 percent to 50 percent and “you’ll get clobbered.” So you need to do the math before you close an account.

If you have a good reason to close a card, such as a big annual fee on a card you don’t use, then consider closing it. Just don’t close a bunch of cards at once. And don’t close credit accounts if you plan to apply for a car loan or mortgage in the next six to twelve months.

Q: Why do we have to pay a fee in order to see our credit scores? Annual credit reports are available at no charge. These scores are so important, why aren't they free as well?

A: Congress never included credit scores when it required the big three credit bureaus to give you one free credit report each year. Many consumer groups believe this should be changed. But the industry makes a lot of money selling these scores.

Want to know your score? You'd be smart to get it from FICO because it’s the most widely used score. If you’re applying for a mortgage, you'll also want to get a score from Experian. They no longer make their FICO score available to the public.

Bankrate.com has a FICO Score Estimator, a free calculator that will give you an estimated range for your FICO score based on 10 questions. It's a simple way to figure out where you stand when you have no plans to apply for credit.

ConsumerMan warning: Don’t respond to an e-mail or Internet ad from some unfamiliar company. Chances are your lender will never use this score.

Q: How does a person who has filed bankruptcy re-establish credit? Since someone who’s gone bankrupt can't file again for a long time, shouldn't it be easier to get credit cards?

A: It used to be that way. These days, many lenders don’t want anything to do with risky borrowers. A bankruptcy hammers your credit score which tells lenders you are a big risk.

Once the bankruptcy drops off your report in seven years, it will be a lot easier to get credit with prime lenders. But you don’t need to wait that long to start rebuilding a good credit history. Get a gas card or department store credit card and pay your bills on time, every time.

“The best option to avoid getting stuck with a sub-prime credit card with hundreds of dollars in fees is to get a secured card,” advises Curtis Arnold, founder of cardratings.com. He suggests contacting “bankruptcy-friendly creditors” such as HSBC or GE Money Bank.

“We’ve heard some amazing do-it-yourself stories where folks coming off a bankruptcy have been able to obtain decent credit scores in a matter of just two to three years,” Arnold tells me.

Gerri Detweiler, credit advisor with Credit.com, says it’s important to review your credit reports to make sure any debts discharged in your bankruptcy accurately reflect a zero balance. Dispute any negative information that is inaccurate or incomplete.

Be careful of all credit card offers you get in the mail. “Read the fine print to make sure you are not agreeing to reaffirm a debt you wiped out in your bankruptcy,” Detweiler advises.

Craig Watts at FICO recommends a site called AfterBankrupcty.com which offers a free educational seminar to people who are in this situation.

ConsumerMan warning: Never pay a credit repair firm to boost your score. These outfits are scams.

Q: I went to refinance my mortgage to take advantage of the low rates and found that my credit score had plummeted from well over 700 to 640. In investigating, I found that I had been sent to collection for an $89 medical bill I thought was paid. There was also a credit card balance of $75 that was paid late – the annual fee on a card I don't use. I admit I’ve been sloppy in my attention to these, but in my defense I have never been late on a mortgage payment, I have zero balances on all of my credit cards, I have a solid income and no car payments. It seems ludicrous that my score can drop by 100 points over one or two minor things, when 10 years of spotless history seems to be ignored.

A: Credit scoring is far from perfect. It is based solely on what’s in your credit files at the big three credit bureaus. It does not include income, equity in your home or whether you have any car payments. “How reliably you repay creditors is a big factor in determining your FICO score,” says FICO’s Watts.

Remember, the computer models for scoring credit have no idea why something happened, only that it did. One little mistake, such as a late payment, can quickly drag down your score. As Greg McBride at Bankrate.com puts it, “Your credit score is much like a reputation – it’s easily damaged but takes much longer to restore.”